Economic News
Will the Dollar Reverse in 2023 After Skyrocketing in 2022?
The U.S. dollar rode its largest wave higher in 20 years on the strength of rising interest rates, making 2022 largely a gold year for the greenback. However, as the year comes to a close, it appears that the dollar is losing ground. As investors look ahead to 2023, a declining dollar could exacerbate the already hazy prognosis for inflation.
According to Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, “We have to watch the dollar closely.” The dollar is approaching its high. The Fed will have a problem if the currency falls and falls hard.
The U.S. dollar’s position against other important currencies was on an upward trajectory for the majority of 2022. The US Dollar Currency Index rose roughly 22% from its mid-January low to its peak in September, while stocks and bonds had double-digit losses. The dollar has, however, given back some of its gains over the previous several months as a result of indications that the Fed will moderate the pace of interest rate increases and evidence that the scorching inflation was cooling. The dollar index, which compares the value of the dollar to a basket of international currencies, has decreased by about 9% from the end of the third quarter, when it reached a 52-week high of 114.78, to its most recent closing of 104. It has gained more than 8% so far this year compared to the Morningstar US Market Index’s loss of more than 17.5%.
The Dollar’s Increase in 2022: Why?
The Fed’s quickest and most aggressive round of rate increases in forty years served as the catalyst for the dollar’s upsurge. The currency, whose movements are closely correlated with the direction of interest rates, rose as foreign investors turned to U.S. Treasuries and the world’s reserve currency in search of better returns and a safe haven in the wake of Russia’s invasion of Ukraine.
The euro, the Japanese yen, and the British pound all declined in value due to the rising dollar.
The situation caused other nations to defend their currencies by raising interest rates and selling foreign reserves to buy back their own currencies, which helped to increase the rate of international inflation that was already rising. The cost of servicing dollar-denominated debt for developing countries has increased due to the rise of the dollar. Large global corporations with U.S. bases reported a significant decline in sales and earnings due to currency effects. According to J.P. Morgan Wealth Management, the strong dollar held down 4% of third-quarter corporate sales growth. And unless they hedged against the dollar, investors who were seduced by higher valuations in foreign companies and the promise of stronger returns saw their assets destroyed this year.
According to Scott Opsal, director of research and equities at the Leuthold Group, “Investors can congratulate themselves on recognizing outperforming stock markets around the world, but they still underperformed the U.S. market in dollar terms.”
What Might Cause the Dollar to Fall in 2023?
Market observers are asking how low the dollar may go and what that might entail for investors in light of the quick and drastic collapse in recent weeks.
Changes in expectations for Fed policy in response to signs that inflation has peaked are the main factor driving the dollar’s decline. Investors now think that the Fed will stop raising interest rates before the second quarter and start dropping them by the end of 2023.
The dollar experienced its greatest two-day decline since March 2009 in November as a result of a more subdued-than-anticipated inflation data, and it had its worst month overall in 12 years. Falling energy prices over the last six months have had a significant role in the improvement of inflation figures.
One of the factors contributing to the dollar’s decline is a slowing of inflation. According to a brief by J.P. Morgan Wealth Management, the other driver would be rising expectations for growth outside the United States, particularly in China and Europe.
As China’s government moves closer to relaxing severe limitations associated with its zero-COVID policy of the previous two years, the country is a particular focus. As a result of optimism regarding the loosening of its financial regulations, the Chinese yuan has gained.
Investors envision a similar expansion when China, the world’s second-largest economy behind the U.S., reopens as they remember the enormous economic boom that occurred as the U.S. emerged from lockdowns.
Phil Orlando, the chief equities market strategist at Federated Hermes, said, “Look what happened to the U.S. in 2020 following the lockdowns.” “The United States GDP (gross domestic product) declined 29% quarter over quarter in the second quarter of 2020. Third-quarter GDP increased by 33%. It was the biggest economic boom ever.
Opsal of Leuthold continues, “The openness in China is not given enough credit. A massive shift in economic activity would result from it.
In comparison, the Fed now expects the U.S. economy to expand by just 0.50 percent next year.
The Federal Reserve increased its federal funds’ rate this week by 0.50% to 4.25% in recognition that it hasn’t done enough to reduce inflation, with a predicted end point of approximately 5.1% by the end of next year. According to Fed Chair Jerome Powell, no rate reductions are anticipated in 2023. He stated that the Fed is steadfastly committed to raising rates until there are definite indications that the trajectory toward its 2% inflation target is feasible.
This has rekindled concerns that the Fed would cause the economy to enter a recession, which would probably be bad for the dollar.
What Effects Would a Weaker Dollar Have?
Shalett claims that increased commodity costs could be one issue that the Fed faces as a result of a declining dollar.
Commodities are priced in dollars, and the two asset classes move in opposite directions: A strong dollar causes commodity prices to decline, and a weak dollar causes commodity prices to rise. At the same time, a declining dollar strengthens other currencies, lowering the cost of commodities for other nations, boosting demand, and promoting global prosperity.
Due to this dynamic, inflation may increase just as the central bank starts to sluggishly increase interest rates in response to reduced inflation readings.
Inflation may resurface if the dollar falls significantly and commodity prices increase, according to Orlando.
The Costs Associated with a Weak Dollar
A declining dollar not only raises the cost of imported products and commodity prices, but also puts more pressure on consumer spending and may raise wage demands. As foreign currencies recover and the expenses of foreign services and goods rise, that international trip you were planning suddenly becomes more expensive.
Additionally, American businesses may see pressure on their margins and earnings as they struggle to pass price increases on to customers.
According to Opsal, fixed-income assets will do better under a weaker currency and overseas assets will do better. The “US stock market” will face challenges.
But there are benefits as well. Exporters would benefit from a falling dollar. Additionally, assistance would be provided to multinational corporations with U.S. bases and extensive international operations that have been negatively impacted by currency translations this year. Additionally, investors who want to benefit from the discounts that foreign equities offer—they typically trade at between 10 and 11 times earnings compared to U.S. stocks, which trade at approximately 18 times—are more likely to see their returns increased by the favorable currency translation.
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